Government Policies, Residential Mortgage Defaults, and the Boom and Bust Cycle of Housing Prices
39 Pages Posted: 4 Dec 2010 Last revised: 25 May 2015
Date Written: November 29, 2010
We develop a dynamic simulation model for residential home prices in an economy where defaults on residential mortgages negatively affect housing prices and aggregate income. This simulation model enables us to study the impact of subprime defaults on prime borrowers and the impact of various government policies on the housing market boom and bust cycle. In this regard, our key conclusions are that: (i) there is a contagion effect from subprime defaults to prime defaults due to the negative impact of subprime defaults on aggregate income, and (ii) monetary policy is the most effective tool for decreasing mortgage defaults and increasing aggregate home prices in contrast to alternative government fiscal policies designed to loosen mortgage credit.
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